The shockingly sensible plan to reform the Texas rainy day fund

Texas Comptroller Glenn Hegar proposed earlier this month significant shifts in management of the Texas rainy day fund, and it’s all shockingly sensible.

I say shockingly not as a dis against Hegar, but rather because I have low expectations that government leaders will do the right thing with taxpayer money.

For Hegar, however, all I can offer is a congratulatory fist bump and an “attaboy.” He’s applying prudent principles of financial management. It’s almost enough to make a financial cynic like me believe in good fiscal leadership.

Three simple financial rules — as true for individuals as they are for governments — come into play with the Economic Stabilization Fund or ESF, in Texas, the so-called rainy day fund.

First, automated savings plans are the best savings plans. Second, investing some money in riskier bets earns the highest rate of return over the long term. Finally, setting aside money during surplus times can make an extraordinary difference in the future — when the lean times inevitably come.

Following these principles — setting aside money automatically, investing for a higher return, and delaying spending until it’s needed — is notoriously difficult for both individuals and governments. I’d say especially governments, because competing financial needs always seem so compelling. And in a democratically elected system, being responsive to citizens is sometimes hard to square with fiscal prudence.

Legislators created the ESF in 1988 to automatically fund itself, mostly by excess oil and gas extraction tax revenue. The fund didn’t amount to much throughout the 1990s, until fracking began to fill up its coffers starting in 2006. The neat thing about the ESF, from my perspective, is the automatic nature of the savings. With a savings plan, you should make a rule and then try not to think about savings as they build up. That benign neglect is the key to success.

The state’s automated savings plan suddenly generated a bit of a windfall. Texas now has the high-class problem of about $10 billion in the ESF, thanks to the fracking revolution. That’s quite a nice “set it and forget it” savings plan.

Regarding investments in higher-risk, higher-yielding opportunities, the ESF has until now always erred on the side of caution and low returns. Historically, the vast majority of ESF funds have earned little more than cash, not even keeping pace with inflation.

With a balance above $10 billion, however, Hegar’s proposal sensibly calls for dedicating a portion of the ESF to higher-return investing. Every $1 billion in the ESF that could earn an extra, say, 4 percent annually would create $40 million in additional government revenue. That’s a pretty conservative assumption considering that S&P 500 has historically generated a 7 percent average annual return after adjusting for inflation. The state’s Legislative Budget Board estimates a net gain for the state of more than $82 million by August 2019 if this bill passes.

Earning an extra $40 million per year by prudently reallocating some of those funds seems like a good plan to me.

Regarding spending those gains, Hegar proposes a Texas Legacy Fund from which future Legislatures could vote specifically for long-term, fiscally prudent projects. If big public pensions suffer a shortfall in the future, something he and I both worry about, funds from the Legacy Fund could plug the hole. Relatively small amounts now, applied steadily to public pensions, could stave off big problems in the future.

So given how sensible this is, will it actually pass this legislative session?

Maybe. (Fingers crossed.)

Hegar’s proposed changes to the ESF came relatively late in the Texas legislative session, through House Bill 855. The enemy of the bill may not be any particular opponent. The limited time remaining in the session is the biggest hurdle. Changes to the ESF can’t be done without a vote in the Texas House and Senate.

HB 855 passed out of the House committee and it’s scheduled to go to the floor for debate Wednesday, but the Senate still needs to hear and opine on the proposal. Hegar’s office is working with the Senate on a joint resolution that would speed the approval process. Voters would need to vote on a constitutional amendment for it to take effect.

Setting fiscal prudence aside and thinking more about my needs, I mentioned to Hegar last week that Alaska has a similar ESF fund but makes an annual distribution — it was $1,022 last year — to every resident. I think of that money as hardship pay for living through those winter months up north.

I’m originally from Massachusetts, and I feel like living in Texas in July and August is worth at least $1,000 per citizen. So I tried convincing Hegar to distribute ESF funds to all citizens of Texas every year in the form of a hardship dividend, given our summer heat.

Hegar countered that the good people of Houston might have a stronger claim to summer hardship payments because of humidity rather than the “dry heat” of San Antonio. Dry heat? I thought to myself. I have three words for Hegar: What. Ev. Er.

I proposed that the comptroller create a distribution chart for every city in Texas determining which people in the state get the best “dividend” by which cities have the worst summer heat. I feel like my city deserves it the most and there’s potentially a lot of money at stake.

Michael Taylor graduated magna cum laude from Harvard in 1995. He was a Fulbright Scholar in Mexico in 1996, and worked as a fixed income consultant from 1996 to 1997. He sold bonds for Goldman Sachs in the Emerging Markets and Mortgage Departments from 1997 to 2004. In 2004, he founded Cedarcrest Capital LLC, a purchaser of distressed fixed income assets. Taylor also serves as finance chair and investment chair for the board of trustees of the Armand Hammer United World College of the American West.

He and his family moved to San Antonio in 2009. He has co-taught a personal finance course at Trinity University and writes the finance blog www.Bankers-Anonymous.com.